• Maintain BUY with lower Target Price of S$0.80 to factor in the Vietnam ASF impact. 
• Factoring in potential impact from Vietnam ASF (African Swine Fever) to our new forecast. 
• Japfa's Indonesia operations likely to perform better in FY19F on potentially higher chicken consumption and stable prices. 
• Japfa's 4Q18 core PATMI is ahead of our estimate. 

Maintain BUY With Lower Target Price of S$0.80 (from S$0.89)

• We maintain our BUY call on JAPFA LTD. (SGX:UD2) with a lower Target Price of S$0.80 (vs S$0.89 previously) after factoring in the potential short-term overhang from its Vietnam operations offset by its Indonesia operations. Japfa Comfeed (JPFA) contributed 66%/67% of revenue/EBITDA in FY18 of Japfa's total consolidated figures. We estimate a higher contribution from Japfa Comfeed in FY19F of 68%/71% of revenue/EBITDA on the back of the following assumptions:
  1. stabilisation of DOC and broiler prices at a high level due to continued undersupply of DOC in 1H19, and
  2. higher chicken consumption in FY19F.

Factoring in Near-term Overhang From Vietnam Operation

• As of late last week, ASF (African Swine Fever) had spread to six provinces, from only two provinces a week earlier, based on media reports.
• We adjust our assumption on Vietnam operations as we lower the volume growth of swine fattening and swine feed in FY19F/20F in anticipation of ASF spreading in Vietnam, increase our assumption on poultry feed, and DOC for Vietnam operation in anticipation of the shift of consumption.
• We forecast Vietnam operation’s EBITDA to decline by 2-5% in FY19F/20F, leading to a downward adjustment on overall group net earnings projections by -0.9%/-2.2% for FY19F/20F respectively.

Shift in Consumption to Offset the Potential Decline in Vietnam Operation

• While there are near-term concerns that ASF could spread wider within Vietnam, the situation for Japfa may not be totally dire. We believe that it would lead to higher demand for poultry and beef in Vietnam and drive up their prices in the short term.
• Based on our sensitivity analysis, the impact on Japfa's consolidated earnings is around 4-8%.

Valuation

• Our Target Price is based on sum-of-parts valuation. Our target price, after incorporating a 15% holding company discount, is S$0.80 (which implies 11.4x FY19F PE).

Key Risks to Our View

• Japfa's share price is driven by DOC, broiler and swine prices, as well as China raw milk price movements and the USD/IDR xchange rate.

What's New - Near-term Overhang From Vietnam Operation; Indonesia Operation to Continue Growing

4Q18 earnings ahead of our estimates.

• Japfa reported 4Q18 earnings of US$39.9m (up from losses of US$0.4m in 4Q17). This brought FY18 reported earnings to US$100.4m. Core PATMI without foreign exchange (forex) came in at US$121.9m, ahead of our estimates of US$106m.
• The strong performance was driven by;
  1. higher EBITDA contribution from Japfa Comfeed of US$321.1m in FY18 (+48.3% y-o-y),
  2. EBITDA turnaround from APO to US$43.5m (vs losses of US$18.7m in FY17) and,
  3. China’s dairy division which improved the EBITDA in FY18 by 9.6% y-o-y to US$102.9m in 9M18.

A first and final dividend of 1 Scts proposed, along with special DPS of 1 Scts.

• The Board has proposed a final dividend of 1 Scts, up from 0.5 Scts in FY17. Along with this, a special DPS of 1 Scts was proposed as well, with 0.5Scts to be paid on or about 21 May 2019 (with the final DPS of 1 Scts), and the remaining 0.5 Scts on or about 31 Oct 2019.

Japfa Comfeed’s contribution remained strong.

• Japfa Comfeed’s strong results were primarily driven by higher DOC and broiler average selling prices (ASPs). The DOC division recorded an exceptionally strong y-o-y ASP improvement due to lack of DOC supply in Indonesia.
• In FY18, Japfa Comfeed revenue increased by 14.9% y-o-y in Indonesian Rupiah (IDR) terms, but only 8% in USD terms due to the depreciation of the Rupiah. Operating profit increased 63% y-o-y due to strong prevailing poultry ASP in Indonesia mainly driven by low DOC supply.

APO recovery in Vietnamese division.

• APO outside Indonesia contributed FY18 EBITDA of US$43.5m (vs losses of US$18.7m in 3Q17). The group attributed the improved performance to its Vietnam operation.
• In Vietnam, revenue increased by US$89.5m driven by higher sales volume for poultry feed (+23% y-o-y), and higher ASP for swine fattening (+57% y-o-y). With the recovery of swine prices, Vietnam turned around to record an operating profit of US$30.9m in FY18 from operating losses of US$33.9m in FY17. The current recovery of prices reflects the re-balancing of demand and supply in Vietnam’s domestic swine market, without any exports to China.
• Myanmar recorded operating losses of US$2m due to higher local corn prices which increased the cost of goods sold (COGS) of feed and led to higher DOC and broiler production cost. As a result, DOC and broiler segments recorded operating losses due to their inability to pass on higher production costs in an increasingly competitive poultry environment in Myanmar.

Dairy milk continues to rise.

• Dairy milk yield improved slightly to 38.9kg/head/day in FY18 (vs 38.4kg/head/day in FY17).
• Despite relatively flat raw milk prices in FY18, the division posted revenue of US$408.7m in FY18 (+17.7% y-o-y) on the back of better volume which offset the flattish raw milk prices. The continued focus is on improving milk yields and volumes in China to mitigate price fluctuations and improve profitability.
• The higher selling expenses in FY18 were due to the launch of the new range of dairy products in Indonesia (e.g. stirred yogurt under the Greenfield brand has been introduced) and resulted in a tightening of operating margins.

EBITDA remained negative in FY18, as expected.

• The consumer food segment's EBITDA contribution remained negative at US$7.9m in 3Q18 due to,
  1. lower ASP of ambient food products due to increased market competition,
  2. inability to pass on the increased production costs arising from higher chicken raw material prices, and
  3. continued investment in advertising and promotions to maintain market share.

Outlook

Japfa Comfeed to remain the growth driver, as supply and demand conditions remain favourable in Indonesia.

• Japfa Comfeed (JPFA) contributed 66%/67% of revenue/EBITDA in FY18 to Japfa's total consolidated revenue and EBITDA figures. We estimate a higher contribution from Japfa Comfeed in FY19F of 68%/71% of revenue/EBITDA on the back of the following assumptions:
  1. stabilisation of DOC and broiler prices at a high level due to continued undersupply of DOC in 1H19, and
  2. higher chicken consumption in FY19F.
• We believe that consumer spending will also be supported by higher wages, and more stable electricity and fuel prices in 1H19. Besides that, the Presidential Election that will take place in April 2019 should also boost consumption, particularly in rural areas.

Vietnam reported first ASF cases at three farms.

• According to news from Reuters on 19 February 2019, ASF was detected at three farms in Vietnam, the first confirmed cases of the highly contagious disease in a Southeast Asian country. All pigs on the farms located in Hung Yen and Thai Binh provinces, southeast of capital Hanoi, were culled. Based on news reports, this has since spread to six provinces, including Thanh a, Ha Nam, Haiphong, and Hanoi.
• The ASF disease outbreak in Vietnam has not affected Japfa’s six swine farms operating in Vietnam, three of which are in Northern part (Hanoi) and rest near Ho Chinh Minh.
• We understand from Japfa that the ASF outbreak detected is far from its farms. Japfa also has a farm in the Thai Binh province, but ASF was detected about 20km away from its farm. So far, detected ASF cases in Vietnam are at backyard farms. Industrialised farms have not been affected yet.

Impact on Vietnam: If ASF spreads further, pork shortage likely.

• If the ASF spreads further within Vietnam, in the medium term, we believe that the Vietnamese authorities will instruct swine operators to quarantine their swine. This could lead to an undersupply of pork in the market, as seen in China when ASF occurred there. This could cause an increase in pork prices. The authorities may fill the shortage (assuming no changes in consumption patterns) by importing pork from countries not affected by ASF (for example, the US). This could likely have an impact on Japfa’s Vietnamese operation, as swine sales volume would decline.

If ASF spreads wider within Vietnam, supply shortages could occur.

• China’s current protein consumption has shifted to beef and poultry due to concerns of ASF affecting pork. Drawing from this shift in consumption pattern, we believe the same could happen in Vietnam and lead to higher demand for poultry and beef, which could drive up their prices in the short term.
• See attached PDF report for detailed scenario analysis to Vietnam ASF.

Lower FY19F/20F EBITDA by 0.4%/1.5%.

• We are adjusting for the potential impact of ASF in Vietnam with lower EBITDA and net profit. The changes are:
  • We adjust our foreign exchange (FX) forecast in FY19F/20F with better revenue growth in FY19F/20F by 3.6%/1% respectively. We maintain our revenue growth assumption in Indonesia. We view Indonesia as the backbone of Japfa’s growth. We see prices of DOC and broiler in Indonesia stabilising and estimate higher volume growth in FY19F.
  • We adjust our revenue growth assumption in Vietnam, as we factor in the potential impact of ASF. We lower our volume growth of swine fattening in Vietnam to - 8%/-10% in FY19F/20F respectively. We assume a higher volume growth in poultry feed by 7.1%/6.7% in FY19F/20F respectively and DOC by 5%/7% in FY19F/20F respectively – all to factor in the potential shift in poultry consumption away from pork due to the ASF outbreak. As a result, our Vietnam revenue forecasts for FY19F/20F have declined by 2%/5%.
  • We adjust down our EBITDA forecast for Japfa’s Vietnamese operations. We lower our EBITDA contribution in the new forecast by -2%/-5%, respectively to factor in the impact of ASF.
  • Our earnings forecasts for Japfa are lowered to -0.9%/- 2.2% for FY19F/20F.

Valuation

Maintain BUY call with lower Target Price of S$0.80.

• We employed SOP valuation based on EV/EBITDA multiple on each segment. Based on our forecast revisions, our target price is lowered to S$0.80, mainly to account for lower contribution from the Vietnamese division. See attached PDF report for SOP valuation details. 
• While there could be near-term concerns on the outbreak of ASP and the impact on Japfa, we believe it could be offset by its strong Indonesia operation.
• Japfa Comfeed (JPFA) contributed 66%/67% of revenue/EBITDA of Japfa's total consolidated revenue and EBITDA figures in FY18. We estimate a higher contribution from Japfa Comfeed in FY19F of 68%/71% of revenue/EBITDA on the back of the following assumptions:
  1. stabilisation of DOC and broiler prices at a high level due to continued DOC undersupply in 1H19, and
  2. higher chicken consumption in FY19F.

Source: DBS Research - 05 Mar 2019